Election Reflection: Economy to continue suffering from political brinksmanship

Thursday, November 08, 2012

The decline in share prices when the market opened the day after the presidential election reflects the economic outlook of the post-election period.
A politically divided Washington indicates that little progress will be made on key policy issues such as the “fiscal cliff,” automatic spending cuts and tax hikes scheduled for January 2013. Inaction will lower GDP by a few percentage points instantly, and other major bills impacting energy, transportation and agriculture will languish. Most likely the fiscal cliff will be postponed; however, it’s difficult to see how meaningful legislation which would resolve the uncertainties that hold private sector investment back will be passed. Yet, there’s hope that the fiscal cliff can be resolved, which should improve the operating environment for the freight movement industry.
In terms of the outlook for the economy and trade, it’s best to consider these potential scenarios:
Near term – The fiscal cliff continues to weigh on investment and employment growth. The consequence could be a decline in GDP of 5 percent in the first half of 2013 compared to the first half of 2012. Concern over the fiscal cliff is evident in the data on company investment in plants, property and equipment, which shows a marked slowdown. Consumer spending, which is not as forward-looking as company spending, continues to grow at a low rate. To some extent this seems to be forcing companies to hire to meet growing consumer demand. It is likely that a long-term postponement or repeal of the automatic budget deficit reduction would see a jump in economic activity as companies reactivated investments they had been planning.
The key question is whether or not Washington can find a way to eliminate the fiscal cliff. There are several arguments that could be used by both parties to accomplish this, with the main one being that the fiscal cliff may not reduce the deficit by the amount of the spending cuts and tax hikes because the negative impact on the economy in terms of lower profits and layoffs would see tax revenues decline and unemployment insurance benefit expenses increase.
There are other global factors that help the outlook to some extent. Europe is making progress on resolving its debt crisis and major developing economies, like China and Brazil, are initiating policies to offset weak export trends by investing in public infrastructure. These trends would not compensate for the impact of the fiscal cliff, but the removal of this threat to the U.S. economic outlook in tandem with a more stable global economy suggests 2013 could see much higher growth than 2012. If so, the transportation industry could be dealing with congestion issues next year, as both imports and exports would grow stronger.
Medium term – The fiscal cliff affects forecasts out to 2015. If 2013 sees a recession due to the fiscal cliff, 2014 and 2015 would be characterized by a slow recovery, supported by more expansionary policy action (quantitative easing) by the Federal Reserve. If the fiscal cliff is eliminated or postponed for many years, the economy would grow quickly in 2013, which would motivate the Federal Reserve to reverse its expansionary monetary policies, potentially as early as the second half of 2013. As the Fed continues to withdraw policy support and eventually begins to raise interest rates, economic growth will slow or come to a standstill, with a modest recession possible. Beyond 2013, the transportation sector could be dealing with a healthy growth in exports and imports, or continued intense competition among industry participants to maintain business.
Long term – Beyond 2015, and regardless of the fiscal cliff outcome, it’s difficult for the United States to avoid a prolonged period of low growth and higher inflation. Baby Boomers are just beginning to retire. Their spending on goods will slow and given that many of them are heavily indebted and possibly unable to afford retirement, the public sector will be pressured to subsidize them. Higher taxes and/or inflation due to the Federal Reserve printing money to buy the government’s debt or some combination of higher taxes and inflation would be the outcome. Interest rates would rise and that would slow investment spending, which would further hold down growth. China could also abandon its policy of keeping the yuan undervalued relative to the dollar since the U.S. market would become less attractive. That would make imported goods more expensive and contribute to inflation. Low-trade growth would extend the already long period of intense competition in the transportation sector.
Yet, it doesn’t have to be like that. The growing emerging market’s middle class represents a major opportunity for U.S. export growth. Export growth would generate jobs and continue to inspire investment spending in export-oriented industries. This would raise productivity and reduce the trade deficit, which in turn would help the dollar strengthen and reduce inflationary pressures. Higher productivity would reduce the need to raise taxes to subsidize retiring Baby Boomers.
Unless the mid-cycle election provides either party control over Washington, the U.S. economic and trade outlook may be impacted by policies deployed by other countries, similar to what’s been the case in the last few years. At this juncture, economists have to look carefully at trends and policies in other countries and regions to develop their forecasts. - Walter Kemmsies, chief economist of Moffatt & Nichol, a marine infrastructure engineering firm.